Household budgets face a good belt tightening as rising interest rates push up mortgage payments

Many households will be in for an unpleasant economic shock over the next couple of years as the low interest rate party comes to an end and people are left with an ugly financial hangover.

The biggest hangovers will be for those who have borrowed up large over the last few years to fund everything from the purchase of their first home, to renovating their existing home or buying a new car.

Younger borrowers are likely to be especially shocked by the change in circumstances because mortgage interest rates have been in more or less steady decline for the last 14 years.

Cheap finance, underpinned by ever rising housing values, is the only economic environment that many younger people have ever known.

And that situation has persisted for so long that many older borrowers have probably forgotten what it is like to live in an environment where house prices are flat or perhaps even falling, while borrowing costs are rising.

They are in for a rude awakening.

The 14 year slide in mortgage interest rates came to an end in May last year when the average of the two year fixed rates offered by the major banks bottomed out at an all time low of 2.52%.

Since then it has moved higher in each and every subsequent month and finished up at the end of last year on 4.21%.

To put that in perspective, that is still relatively cheap by historical standards because it only takes mortgage rates back to where they were about three years ago and they would have been considered cheap at the time.

So anyone who took out or re-fixed a mortgage about three years ago and is due for another fix about now, probably won’t notice much change in their mortgage payments.

Those who took a longer term punt and last fixed their mortgages for a five year term and are due to refix now will probably get a reduction in their mortgage payments because they’ll be re-fixing at a lower rate.

But they are likely to be a small minority, with most people fixing for shorter terms.

So in everyday dollar terms, what will rising interest rates mean for most mortgage holders?

The table below shows how changing interest rates could affect the fortnightly payments for different sized mortgages.

It suggests that someone with a $500,000 mortgage who last fixed about two years ago ago when the two year rate was around 3.5% and is looking to re-fix this year at closer to 4.5%, could be looking at an extra $132 a fortnight in mortgage payments.

If their mortgage was $700,000 they could be looking at an extra $185 a fortnight.

It seems likely that mortgage rates will keep rising this year and could go above 5% for popular fixed terms next year, so some borrowers could be facing even bigger increases further down the track.

With cost increases now prevalent on a wide range of household goods and services from petrol to groceries, the effect of even modest increases in mortgage payments should not be underestimated.

The people most at risk in this environment will be those who borrowed the absolute maximum they could afford when interest rates were at or near their lowest point in the middle of last year.

They will be squeezed especially hard and the worry is that some may find it difficult to keep themselves financially afloat.

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